Property transfers in divorce are not necessarily tax-free, but they are tax-deferred. Section 1041 of the Tax Code treats property transfers in divorce much like gifts rather than taxable income. The same law applies to property transfers between married spouses and spouses who are getting divorced. When property is transferred between spouses, the transferree receives a “carryover tax basis,” which is equal to the transferor’s tax basis. For tax purposes, the tax basis is the starting point for measuring taxable gain. Carryover tax basis means that the property keeps the same value, for tax purposes, that it had when the transferor acquired.
When the property is sold by the transferee, there may be a taxable gain, measured by the difference between the sale price and the carryover tax basis. For instance, a stock that was worth $10 when a wife bought it is transferred to the husband when it is worth $15. Later the husband sells the stock for $17, and he will have to report a $7 taxable gain (not $2 gain). The holding period is also carried over. This is why divorcing spouses should agree to exchange tax basis information as part of their settlement agreements.